Asset Management Insights May 2021 Asset Management Insights May 2021 Asset Management Insights May 2021

Welcome to our monthly KPMG Asset Management Insights newsletter, which has been designed to keep you up to date on topical issues within the Asset Management sector.

KPMG Insights

• CBI perspective on Operational Resilience

Central Bank of Ireland updates

• Central Bank of Ireland publishes guidance on performance fees of UCITS and certain types of retail investor AIFs
• Central Bank of Ireland publishes 38^th edition of AIFMD Questions and Answers
• Central Bank of Ireland issues consultation paper on cross-industry guidance on operational resilience

European Commission and ESMA updates

• ESMA publishes annual statistical report on AIF sector
• ESMA publishes annual statistical report on the cost and performance of EU retail investment products highlighting the high cost of investment products
• European Commission adopts package of measures to help improve flow of money towards sustainable activities across the EU
• EBA consults on its proposals for an AML/CFT database

Industry and other updates

• EFAMA publishes latest funds statistics for February 2021
• IOSCO reviews implementation of liquidity risk management recommendations and market participants’ responses to COVID-19 induced market stress

KPMG, led by Owen Lewis (Head of Management Consulting), Ian Nelson (Head of Regulatory, Head of Banking and Capital Markets) and David Polley (Director, KPMG Management Consulting) from the KPMG Operational Resilience team explain how strengthening resilience throughout the financial system is one of the strategic commitments by the Central Bank of Ireland (CBI). KPMG notes that resilience includes understanding existing vulnerabilities and mitigating those risks to ensure the financial system can withstand and limit the impact of future disruptions.

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On 1 April 2021, the Central Bank of Ireland published its guidance on performance fees of UCITS and certain types of retail investor AIFs. The guidance applies only to UCITS and to Retail Investor AIFs other than those retail investor AIFs that are closed-ended and open-ended Retail Investor AIFs that have been established as a European Venture Capital Fund (‘EuVECA’), Eureopan Social Entrepreneurship Fund (‘EuSEF’) or follow venture capital, private equity or real estate strategies. The guidance applies at fund-level and covers the following areas:

• The method to be used in the calculation of performance fees;
• Ensuring consistency between the performance fee model and the fund’s investment objectives, strategy and policy;
• The frequency for the crystallisation of the performance fee;
• Negative performance recovery; and
• Disclosure of the performance fee model.

For in-scope funds which are established or which amend or introduce a performance fee on or after 5 January 2021 the guidance applies from the date of establishment, amendment or introduction. However, for in-scope funds with existing performance fees as at 5 January 2021, the Guidance will apply from the beginning of the accounting period on or after 5 July 2021.

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On 1 April 2021, the Central Bank of Ireland published the 38^th edition of the AIFMD Questions and Answers, with two new Q&As added.

Q&A 1141 relates to raising capital from investors by way of a shareholder (unitholder) loan. The Central Bank notes that the AIF Rulebook does not envisage or specifically permit arrangements which involve loans between an authorised AIF and its members (investors) and that such arrangements do not appear to be consistent with the objective of collective investment on behalf of an authorised AIF’s members. However, the Central Bank notes that it may revisit this matter during future public consultations.

Q&A 1142 relates to whether an authorised AIF can enter into transactions with its investors. The Central Bank notes that the AIF Rulebook does not envisage that transactions other than the issuance or redemption of units or shares in the authorised AIF would take place between an authorised AIF and its investors. As such , the AIF Rulebook does not currently apply rules which relate to transactions with connected parties to transactions with investors. However, the Central Bank goes  on to set out its expectations of AIFM, AIF and its depositary where such a transaction is proposed, including consideration of: (i) the requirements under Regulation (EU) No. 231/2013; (ii) the purpose and motivation behind the transaction; and (iii) whether the proposed transactions is at arm’s length and on normal commercial terms, and whether best execution principles have been applied. In addition, the AIFM and the AIF’s depositary should also be satisfied that there is no prejudice or potential prejudice to other investors in the authorised AIF as a result of the proposed transaction.

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On 9 April 2021, the Central Bank of Ireland issued a consultation paper on cross-industry guidance on operational resilience (‘CP 140’) in order to understand the views and experience of all regulated financial service providers (‘RFSPs’), including AIFMs, UCITS and fund management companies, in advance of finalising guidance on how to prepare for, respond to, recover and learn from an operational disruption that affects the delivery of critical or important business services. In particular, the guidance seeks to:

• Communicate to the boards and senior management of RFSPs the Central Bank’s expectations with respect to the design and management of operational resilience;
• Emphasise board and senior management responsibilities when considering operational resilience as part of their risk management and investment decisions; and
• Require that the boards and senior management of RSFPs take appropriate action to ensure that their operational resilience frameworks are well designed, are operating effectively, and are sufficiently robust.

This follows the recent challenges RFSPs have faced as a result of COVID-19, and against the backdrop of the evolving landscape of operational resilience at an international level, including the development of the BCBS principles for operational resilience. Once the Central Bank’s guidelines are finalised, it is its expectation that RFSPs adopt appropriate measures to strengthen and improve their operational resilience frameworks and their effective management of operational resilience in line with the guidelines.

The 15 guidelines are built around three pillars of operational resilience, namely:

• Identify and Prepare (Guidelines 1-10) – concerning governance, the identification of critical business services and impact tolerances, mapping of interdependencies, ICT/Cyber resilience and scenario testing;
• Respond and Adapt (Guidelines 11-13) – concerning business continuity management, incident management and communication plans; and
• Recover and Learn (Guidelines 14-15) – concerning lessons learned exercises and continuous improvement.

The consultation closes on 9 July 2021.

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On 8 April 2021, the European Securities and Markets Authority (‘ESMA’) published its third annual statistical report on the Alternative Investment Fund (‘AIF’) sector, and identifies the main risks faced by the sector as relating to a mismatch between the potential liquidity of the assets and the redemption timeframe offered to investors. The AIF sector was heavily impacted by COVID-19 related market stress during Q1 2020, and while this is outside the reporting period (31 December 2019), a snapshot of the main event is included in the report.

The main findings of the report were:

• The size of the EU AIF universe continued to expand, reaching €6.8tn in NAV at end-2019, a 15% increase on 2018;
• Funds of funds accounted for 15% of the NAV of EU AIFs – at the very short end, investors could redeem 39% of NAV within one day, whereas only 29% of assets could be liquidated during that timeframe;
• Real Estate Funds accounted for 12% (€802bn) of the NAV of EU AIFs, which continued to grow, albeit at a more moderate pace compared to previous years. Compared with 2018, the proportion of retail investors was stable (21%) but remains high compared with other AIF categories, and liquidity risk remains a concern;
• The size of the EU Hedge Fund sector remained stable in 2019 at €354bn (5% of all AIFs), however given their heavy reliance on derivatives, hedge funds accounted for 62% of all AIFs when measured by gross exposures;
• Private Equity Funds accounted for 7% (€456bn) of the NAV of all AIFs, and experienced the largest growth in 2019 (+28% compared with +66% in 2018). They follow a range of strategies and are almost exclusively sold to professional investors;
• Other AIFs accounted for 60% (4tn) of the NAV of EU AIFs, covering a range of strategies, with fixed income and equity strategies accounting for 68% of the NAV and an additional residual category amounting to 29%;
• EU Member States can allow non-EU asset managers to market alternative funds at national level under the National Private Placement Regime (‘NPPR’), even though such funds cannot subsequently be passported in to other Members States. This market is comparatively large, with a NAV of €2.1tn. NPPR fund marketing is concentrated in a small number of Member States, with 98% of investors being professional investors.

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On 14 April 2021, ESMA published its third annual statistical report on the cost and performance of European Union (EU) retail investment products, which provides that the costs of investing in key financial products, such as UCITS funds, retail investment funds, and structured investment products, remains high and diminishes the investment outcome for financial investors. The report aims to facilitate increased participation of retail investors in capital markets through the provision of consistent EU-wide information on the cost and performance of retail investment products.

The report’s main findings include:

• UCITS costs only marginally declined over time for one-year investments (1.4% in 2019 compared to 1.5% in 2018 on average across asset classes);
• The existence of volatile returns, with performance dependent on market developments, and which varies significantly over time;
• Retail clients pay on average 40% more than institutional investors across asset classes;
• Higher risk exposures entailed higher costs irrespective of asset class;
• Costs were higher for active equity and bond UCITS compared to passive and UCITS ETFs, ultimately implying net underperformance of active equity and bond UCITS, on average, compared to passive and UCITS ETFs. The top-25% active equity UCITS overperformed compared to the top-25% passive and related benchmarks, at shorter horizons – however, the cohort of UCITS changes over time making it complicated for investors to consistently identify outperforming UCITS;
• ESG funds outperformed non-ESG equity UCITS mostly due to sectoral factors, with actively managed ESG funds showing lower costs than non-ESG funds, which does not support the view that there is systematic greenwashing by ESG funds;
• Retail AIFs showed high return volatility – while being negative in 2018, gross annualised returns in 2019 were 12% for Fund of Funds (FoFs) and 9% for the residual category "Others" which includes investment primarily focused on equity and bonds.
• Structured retail products’ total costs were largely attributable to entry costs, and varied substantially by country and payoff type, with little difference in simulated returns between moderate and favourable performance scenarios; and
• In respect of transparency, there is limited comparability across Member States – heterogeneity and data availability issues persisted, as well as lack of harmonisation in national regulation.

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On 21 April 2021, the European Commission adopted a package of measures to help improve the flow of money towards sustainable activities across the European Union, which are considered to be instrumental in making Europe climate neutral by 2050.

Among the measures includes a proposal for a Corporate Sustainability Reporting Directive (‘CSRD’) which aims to improve the flow of sustainability information in the corporate world by making sustainability reporting more consistent so that financial firms, investors and the broader public can use comparable and reliable sustainability information. The proposals extend the scope of reporting rules beyond public interest entities, to include all large companies, irrespective of whether they are listed, and without the previous 500-employee threshold. In addition, the Commission proposes to extend the scope to include listed SMEs, with the exception of micro-enterprises. The European Financial Reporting Advisory Group (‘EFRAG’) will be responsible for developing the draft standards, following public consultations.

In addition, the Commission has also adopted six amending Delegated Acts on fiduciary duties, investment and insurance advice to ensure that financial firms, including asset managers, include sustainability in their procedures and investment advice to clients.

The European Fund and Asset Management Association (‘EFAMA’) called for prompt adoption of the CSRD proposal, as being essential in reducing the ESG data gaps faced by asset managers and supporting the development of green products. EFAMA supported the Commission’s proposal as it considers that it:

• expands the scope of reporting companies to enable asset managers to consider sustainability risks and opportunities, assess adverse impacts of investments on sustainability factors and calculate their green asset ratio;
• requires the Commission to take account of EFRAG’s technical advice;
• clarifies the principle of double materiality and requires companies to assess and disclose the information that is material;
• requires the submission of financial statements and management reports in a single, comparable electronic format, with digitally tagged sustainability information; and
• seeks legislative consistency with the information needed to company with the SFDR disclosure requirements and the forthcoming taxonomy-related technical screening criteria.

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On 6 May 2021, the European Banking Authority issued a consultation paper on draft Regulatory Technical Standards concerning the creation of a central database on anti-money laundering and countering the financing of terrorism (‘AML/CFT’) in the EU. Law introduced in January 2020 requires the EBA to establish and keep up-to-date a central database with information on AML/CFT weaknesses that national competent authorities (‘NCAs’) across the EU have identified in respect of individual financial institutions. The database will also contain information on the measures competent authorities have taken to rectify those material AML/CFT weaknesses, and that data will be used by NCAs and the EBA to allow them to be more targeted and effective in its fight against ML/TF in the EU, as well as serve as an early warning tool to enable the NCAs to act before the ML/TF risk crystalizes.

The draft RTS provide for the definition and materiality of weaknesses identified by the NCAs, the type of information collected, how that information will be communicated to the EBA, and how the EBA will, in turn, analyse and disseminate the information. The RTS also set out the rules to ensure the database’s effectiveness, as well as protection of confidentiality of the data, including personal data.

The EBA has also performed a draft Data Protection Impact Assessment alongside the consultation paper in order to assess the impact of the processing on the fundamental rights to privacy and the protection of individuals’ data, and to determine whether the mitigation measures taken sufficiently limit the risks to the rights of individuals, taking account the scale of the database and the fact that special categories of personal data may be processed and further shared.

The consultation closes on 17 June 2021.

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On 26 April 2021, EFAMA published its latest monthly Investment Fund Industry Fact Sheet, providing net sales data of UCITS and AIFs for February 2021, which totalled €38bn, down from €83bn in January. UCITS recorded net inflows of €34bn (€66bn in January), with AIFs recording net inflows of €3bn (€17bn in January). Total net assets of UCITS and AIFs increased by 0.6% to €19.1tn.

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On 3 March 2021, the International Organization of Securities Commissions (‘IOSCO’) launched its Thematic Review of the Recommendations for Liquidity Risk Management for Collective Schemes issued in 2018. The recommendations were meant to ensure that liquidity risk was managed to safeguard and protect the interests of investors, including in stressed market conditions, and also to address potential structural vulnerabilities in the asset management sector that could impact on financial stability.

The Thematic Review aims to assess the extent to which the Recommendations have been implemented through member regulatory frameworks, and aims to gather information about how responsible entities have implemented them in practice, with a final report expected in Autumn 2022. In addition, IOSCO and the Financial Stability Board are conducting a joint analysis on the availability, use and impact of liquidity risk management tools for open-ended funds, examining the COVID-induced market stresses of March and April 2020 and the use and impact of liquidity risk management tools. 

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For further information on the issues mentioned above, or any related issues, please contact Frank Gannon, Head of Asset Management.